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Reducing Claw-back Risk - Acquiring Distressed Claims and Assets During Periods of Market Dislocation

Client Alert | 2 min read | 05.11.20

As the economic impact of COVID-19 continues to unfold, opportunities to purchase debt and claims at attractive prices from sellers who may be starved for liquidity have started to increase. In such periods of market dislocation, even good-faith purchasers may risk claims of “constructive fraudulent transfer”, “constructive fraudulent conveyance”, or a similar “claw-back” suit if the seller was (i) insolvent at the time of the transaction, or (ii) rendered insolvent as result of the transaction. Claw-back causes of action are typically asserted by spurned creditors of the seller that have unsatisfied debts, or by bankruptcy trustees or official committees of unsecured creditors if the seller subsequently files for bankruptcy.

While the definition of a “constructive fraudulent transfer” or a “constructive fraudulent conveyance” varies by jurisdiction, both terms mean a transfer for less than “fair consideration” was made when the seller was insolvent or rendered insolvent by the transfer, or that the remaining assets of the seller after the transfer are unreasonably small in relation to the seller’s ongoing business. To remedy the situation, the buyer may have to return the asset (or its value) in order to satisfy the seller’s liabilities to creditors, liabilities that the buyer did not agree to assume – and which buyer may have expressly provided were to remain with the seller.

Assuming the seller was insolvent at the time of the transaction, one of the main prongs in analyzing whether the transaction is categorized as a constructive fraudulent transfer is whether buyer paid “fair consideration” or “reasonable equivalent value.” (Whether an entity is “insolvent” is another major factor that should be analyzed in any defense to such an action, but that is a topic to be covered in another article.)

To protect against this risk, buyers of distressed assets should work with counsel to support the fairness of the purchase price, including by taking one or more of the following precautions, depending on the circumstances surrounding the sale process and the debt or claim at issue:

  • Locating and documenting current market pricing for the debt/claim or similar debt/claims that are being sold in the market to help establish that the pricing, however dislocated, represents the current fair market value. This can be accomplished by obtaining quotes from other brokers, market participants or taking contemporaneous notes on research or information obtained from the market. Saving these notes or research will become valuable evidence in any potential future litigation many years later.
  • Consider purchasing assets only through an open quotation or auction process. While not ideal, an auction process helps establish independent evidence of fair market value.
  • If seller’s bankruptcy is imminent, consider whether the asset should be purchased through a bankruptcy sale process (also known as a Section 363 sale), which will be authorized by a court order finding that fair value was paid.
  • Obtain representations, warranties from the Seller, or a guaranty from a related entity, confirming the Seller’s solvency, ability to pay its debts as they become due, and the fair market value of the distressed assets that are the subject of the transaction. While these representations may not provide a complete defense to a lawsuit, they may provide an additional avenue for recovery in terms of a separate counterclaim or claim.

The current market dislocation will provide buyers of distressed debt, claims and other assets with significant opportunities -- but these opportunities should be thoughtfully undertaken given the inherent risks of detailed future scrutiny by creditors of insolvent sellers. Please contact us for further information or guidance.

Insights

Client Alert | 4 min read | 08.07.25

File First, Facts Later? Eleventh Circuit Says That Discovery Can Inform False Claims Act Allegations in Amended Complaints

On July 25, 2025, the Eleventh Circuit Court of Appeals issued its decision in United States ex. rel. Sedona Partners LLC v. Able Moving & Storage Inc. et al., holding that a district court cannot ignore new factual allegations included in an amended complaint filed by a False Claims Act qui tam relator based on the fact that those additional facts were learned in discovery, even while a motion to dismiss for failure to comply with the heightened pleading standard under Federal Rule of Civil Procedure 9(b) is pending.  Under Rule 9(b), allegations of fraud typically must include factual support showing the who, what, where, why, and how of the fraud to survive a defendant’s motion to dismiss.  And while that standard has not changed, Sedona gives room for a relator to file first and seek out discovery in order to amend an otherwise deficient complaint and survive a motion to dismiss, at least in the Eleventh Circuit.  Importantly, however, the Eleventh Circuit clarified that a district court retains the discretion to dismiss a relator’s complaint before or after discovery has begun, meaning that district courts are not required to permit discovery at the pleading stage.  Nevertheless, the Sedona decision is an about-face from precedent in the Eleventh Circuit, and many other circuits, where, historically, facts learned during discovery could not be used to circumvent Rule 9(b) by bolstering a relator’s factual allegations while a motion to dismiss was pending.  While the long-term effects of the decision remain to be seen, in the short term the decision may encourage relators to engage in early discovery in hopes of learning facts that they can use to survive otherwise meritorious motions to dismiss....